Toward the VAT?

Bruce Bartlett comments on an interesting report on tax reform in California:

The main point the report makes is that the nature of the economy and the nature of income have changed over the years, but the tax system has not changed to deal with them.

First, income has become more volatile as people receive less of it in the form of relatively stable wages and more in the form of capital gains, bonuses and stock options that may vary significantly from year to year.

Second, services are much bigger as a share of both production and consumption. By their nature, services are harder to tax than goods.

Third, technology and globalization make it easier for people to purchase goods and services across state and national borders, and to move capital and income to other jurisdictions where they are taxed at lower rates or not taxed at all.

As it has become harder for the state to tax certain forms of income and output, it has had to raise rates on those that it can still tax. This has led to very high marginal rates that impede economic growth and create unfairness.

The proposed tax reform would broaden the tax base by replacing the corporate income tax with a business net receipts tax that would be very similar to a value-added tax. It would also replace the state sales tax and significantly reduce the personal income tax.

The report is here. Tax reform is hard, but if we could actually do it, there's low-hanging fruit. We could have a tax system that raised the same amount of money but was less burdensome and did more to promote economic growth.

Of course, you could say the same about the health-care system. In theory, health-care reform could cover more people and cost less money. But that turns out to be tricky in practice.

If you think health care is hard, just wait... There are far too many interests involved in the convoluted tax system we have. Not the least of which is a whole constituency of about 50% of taxpayers who pay no federal income tax at all. And a lot of these folks are not who you would initially think they would be. One is my boss who earns mid six figures.

The better I've done the more my tax return resembles Dick Cheney's and Warren Buffet's. The numbers are vastly different, obviously, but the effective rate is the same. 15%. And I could eliminate most of what I pay if I incorporated. And I could eliminate a lot of the rest if the company I work for would allow me to defer some more of my compensation. That trick is reserved for top echelon execs.

The best thing about a VAT, of course, is that taxes are so buried that most people will never notice exactly how much they are being taxed. It's the perfect recipe for an ever-increasing tax burden!

It's more regressive than the current income tax, of course, but the politicians will "fix" that by putting in all sorts of special exemptions. A cynic might say, of course, that putting in all sorts of special exemptions is exactly why our current income tax system is such a mess. But I'm positive that wouldn't happen with a VAT; after all, our current set of politicians are so much more resistant to political pressure than they used to be.

Aren't the trends in how compensation, etc are structured at least in part responses to the structure of tax law? This is akin in many ways to financial regulation -- a lot of innovation is geared toward sneaking around the regulatory corners.

"less burdensome"? For whom? Are you aware it will be the low income families who will have to bear the highest burden of a VAT, because they consume the biggest part of their salaries? And that it will be the rich, who invest a significant part of their income, who will pay a lower percentage in taxes?

Really, Ezra, more and more you're becoming a carnival barker for the rich and powerful! Don't tell me that you didn't see the obvious problem with such a tax reform. You're much too intelligent for this.

Gray62, any tax system can be structured to be progressive if the desire to do so is there. Would we end up with a very progressive system if we started from scratch in this political environment? Count me as skeptical, but that doesn't mean that in theory you couldn't work out a way to do that that would be fair.

The Parsky Commission report to which Bartlett is referring, run by a former Bush Ranger, would save millionaires an average of $109,000 a year while saving someone making $50,000 a year 4 dollars. This is not just shrinking the sales tax and broadening the base. It ELIMINATES THE CORPORATE INCOME TAX ENTIRELY and makes the personal income tax almost flat. It would bring the glories of the Latvia flat tax system to American shores. And the business net receipts tax in its place, not a VAT, would tax payroll, hitting high-income corporations like those in the knowledge economy much harder than service sector employers.

It's about the worst deal you could possibly come up with, and it's DOA even among Republicans in California. It's not going to happen.

Sometimes the bubble that surrounds DC becomes blindingly clear, when we see someone inside the bubble who thinks they are looking out, but are instead simply reporting on DC being reflected back at them from the inside of the bubble.

Yes, the wealthy always like to increase the share of consumption taxes, because then the income they devote to maintaining and increasing their status as wealthy people is not taxed.

But Bruce Bartlett gives away too much of the game when pointing out the increasing share of income going to things with volatile tax receipts. The reason an increasing share of income is going to all these things that are not taxed as much IS BECAUSE THEY ARE NO LONGER TAXED AS MUCH AS THEY USED TO BE.

Corporate income taxes used to be the second largest source of Federal tax receipts, after personal income tax and before payroll income tax. It is now third.

And the frame itself is quite insane. The argument that we should stabilize tax receipts for a given level of economic downturn is, of course, the argument that MORE EXTREME economic downturns when we slide into recession. It is an argument that the amount of unemployment generated by the rapid increase in the propensity to save was not high enough in the current recession, and we need to reform the system so that if a similar scenario occurs, we can get more unemployment out of it.

Given the egregiously outcome that Bartlett is arguing FOR, it seems a quite reasonable course to take his policy advice and multiply by (-1) to arrive at the point of departure toward more reasonable reforms.

Depending on how it is structured, a VAT isn't regressive. It's similar to a flat tax on lifetime wealth. The tax may be regressive when looking at a given year, but it should be very close to flat when considered over a person's life, assuming most of lifetime income becomes lifetime consumption.

The whole purpose of saving is to finance consumption. If a person ends up with a big pile of money after they die, then sure, their effective lifetime tax rate on income was less than the statutory rate - but then again they also didn't get to enjoy spending said income. In fact, by investing the money that person increased the pace of capital formation, which was beneficial to economic growth. It's not even as if the income escapes taxation at death - when that person's heirs eventually spend it, it will be taxed (perhaps taxed twice if the estate tax remains in place).

At any rate, nearly half of taxpayers aren't contributing to the operations of the Federal government (by which I mean operations which aren't simply cash transfers - such as the military, administration of justice, interest on the debt, etc). I'm not saying let's hose the poor, but would it hurt for them to contribute SOMETHING? Worse still, some of those without federal income tax liablity make quite a lot of money - having a VAT would remedy that problem to some degree.

If you are still worried about progressivity, use the VAT to pay for healthcare subsidies for the poor and lower middle class. The system becomes progressive when looking at what the tax actually funds. Remember, European countries with very low levels of inequality and poverty also have very high VAT rates - VAT helps those nations to fund lots of social welfare programs. Using a consumption tax to fund social programs is probably a good liberal/conservative compromise, provided more conservatives start thinking like Bruce Bartlett and less like Rush Limbaugh.

Finally, it's not as if there would be a single VAT and no other taxes in the system. Combining the VAT with either a progressive income tax or even a flat rate income tax that had a high standard deduction and a higher rate than the VAT rate would create a progressive system as well.

*****The best thing about a VAT, of course, is that taxes are so buried that most people will never notice exactly how much they are being taxed. It's the perfect recipe for an ever-increasing tax burden!*****

That's a myth -- and a particularly absurd one. Nearly every time I've visited a country with a VAT in place, the final VAT tab is added to the bill in clear, fully disclosed fashion.

With regards to tax revenue stability, at the state level it is fairly important - particularly for California given its experience over the past year or so.

At the national level, absolutely agreed that volatile pro-cyclical tax revenue acts as an automatic stabilizer and that is a feature, not a bug.

I think a VAT could be an excellent counter-cyclical fiscal policy tool. As unemployment starts to rise, the government can lower VAT by 2-3%. If unemployment keeps rising, it can be knocked down another couple of percent. Since the public knows a recovery will bring with it higher VAT rates, those who can will have a higher propensity to spend, smoothing consumption during the downturn. Especially if we use part of the VAT revenue to fund a scaled up (think Denmark) unemployment insurance program.

"the final VAT tab is added to the bill in clear, fully disclosed fashion."

Apparently this differs by country.

http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/BeginnersGuideToTax/DG_4015895
"Most retail prices on bills and receipts include VAT - it is not shown separately. However some may have a line under which they show the VAT element. "

Frankly, I've been to enough different countries to completely and utterly forget which ones have which variant of which system. In India, some states have the VAT and some do not, which is even more confusing.

But even for the countries you are familiar with, do you get a single yearly statement of exactly how much your tax cost was over the course of the year? You know, a 1040-equivalent? That's the moment of truth and pain that I was thinking about...

I'm sure businesses total up all the receipts that they get over the course of the year -- they have to -- but I imagine individual consumers normally do not. I'll admit, I have not been a permanent legal resident of any VAT-using country, so possibly I am not aware of some detail in that regard.